Mind Without Fear said :
"could you please comment on another aspect of strategies that are based on moving average cross overs? I find that there are inevitable periods of whipsaws that eat away profits. Typically, after a big move, there are a series of false signals generated by the cross over system. What filter can be used to not trade these false signals? I mean I know there will be false signals, I just want to avoid some of them, avoiding all of them is not possible. Will really appreciate your thoughts on this."
This excellent question really deserves an answer, as early as possible. Avoiding whipsaws while trading moving averages (MA) is a trader's dream. Why ? MA ensures that all big trends are captured by the trader. But, when the market does not have a trend, the MA casues a lot of trading with almost all of the trades losing money. We continue to trade with MA signals since one of these signals is likely to be the 'Big One'. Unfortunately, we do not know which one, so we take all signals. This becomes a vicious circle - MA trades are taken since one of them may be the big one - the trades keep on losing money since this is a choppy market - then even more reason to take the trades since the losses will be compensated by the big one - choppy markets continue.... Finally, the trader gives up and says "I do not want to take the next trade" - and the next trade happens to be the big one.
Is there some way that can reduce the number of false trades caused by choppy markets ? Before we discuss this, I must explain that trading is never easy. There are no mathematical formulas to get the right entry and exits. So, the pain really goes with the gain.
Now, for some ideas.
1. Trading Ranges. Many of these 'false' signals come inside trading ranges. Now the first one or two signals may come in when the range is under development, so you really do not know that you are in a trading range. Once or rather, IF, you can identify a range, then you can stop taking signals until prices move out of the range. Suppose the latest MA signal was a sell, then you wait patiently for prices to close below support. That is the point when you will take the sell signal. Once you take the signal, you should follow the MA trade .
2. Filters to entry exit signals. When MA signal is received, then buy only above the high of the last 3 bars or sell only below the low of the last thee bars. Many choppy signals will fail to cross this threshold. You can innovate by creating your own 'buy above' and 'sell below' levels.
3. Multiple contracts. If you can trade in multiple contracts, take profits on some of the positions on a big move (range expansion) in your favor. While this method does not improve the quality of your signals, it does ensure a smoother profit curve.
4. Pyramiding. Start with the lowest possible number of contracts when a new signal comes. As the signal becomes profitable, add more contracts. Therefore, the choppy signals will be stopped out with the smallest volume, while the winners will add profits on more contracts.
5. Higher time frames. if you are trading on 60 minute charts, use a daily chart to determine the trend. Then, on the 60 min, take trades only in the direction of the daily trend.
Think out of the box, and, you will find many innovtive ideas. Then follow a few, consistently.
5 comments:
Very good post sir. I would like to add my little bit. I think as traders who follow such mechanical system, one can live with the little losses on whipsaws.
Atleast I have seen from my backtesting of Indian markets - our markets are still very inefficient. That means a lot of strategies which have long stopped making money on Dow or FTSE or Fx pairs still make money, and lots of it, even despite the whipsaws.
And infact even the whipsaws are not that frequent as compared to the no of big trends that we get. Its due to the herd mentality of fund managers and FII money ( lot of it indian money only rerouted), so when there is a move in one direction they just pile on. This can be simply noticed if you do a simple count of how many directional runs we see (runs test).
So guys, really dont need to avoid taking trades. I would stick to taking all trades, and this I have learnt recently - and I have sworn to myself Im not going to guess mkt direction when i have a fixed setup in place which works so well. You just have to blindly follow the system, which is what a lot of us actually fail to do.
Maybe one day the system will stop working when our markets get more efficient, but till then its 'stick to my system' for me.
But for people who prefer to also trade from their understanding of charts, the pyramiding concept is awesome I think. I follow it in trading fx. Many small losses when trades dont work out (success ratio ranges from 35-40% only). But when the big trend comes (like it has started Fri-today), you add on to positions & just sit on it. So, with low 35% ratio, but average gain to average loss of 3:1, one still makes plenty of money.
Cheers,
Piyush
Great ideas
That will surely help.
Sir can you also explain when does a "dip" qualify as a "dip" , what is dip ?
One definition can be that in an uptrend , when prices correct and touch near 100 EMA or 50 EMA , we can say it was a dip and buy there , I know that it depends on the timeframe .
But can you also shed some more light on this . Because often it happens that traders buy at what they consider as dip and still market goes aginst them to cross there risk-apetite and they have to get out at SL , only to see that market finally went in there expected direction .
Manish
http://www.jagoinvestor.com
hats off
Thanks Sudarshanji. I feel a bit relieved now both because it is not a problem that only I have faced but, more importantly perhaps, I have also thought about employing idea number 1 ( trading ranges ) and 3 ( multiple contracts ). Among the other ideas that you discussed, personally I am attracted to idea 2 ( Filter to enter / exit signal) and 4 ( Pyramiding ).
Thank you again. Sir, please ask CNBC to do a camp ( with you ) in Bangalore. It will be such a pleasure for me to meet you.
Warm Regards, ...
Thanks, this was too good. Just wanted to add an important point to the ongoing conversation.
Using ADX alongwith MAs would help in trading choppy markets. As ADX indicates strength of the trend, it would help us in reducing trades and take only those trades when ADX value is above 30.
Going by your point 5, trend can be determined using MAs in the higher time frame and trades can be timed in the shorter time frame using ADX, MAs and MACD histogram.
Our usual stoploss tactics using money management & technical analysis would help us in reducing
risk per trade.
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